TAM SAM SOM: Why it Matters to Your Startup?

January 29, 2023

The process of estimating the market size is one of the most vital tasks that any startup needs to carry out at the initiation stage of the business.

Obviously, the key to validating an unproven startup idea is to develop a quick sense of what the size of the market for that particular problem is. This should happen before starting to work on the solution as it will help you determine whether it's even worth going after a specific market with a product or service you have an idea for.

By determining your current market size, it becomes easier to identify if you should go through the VC or bootstrapped path. Since most VCs typically only want to fund fledgling businesses that would eventually become unicorns—companies worth hundreds of millions of dollars, you can make sure your startup idea has a widespread market potential before going in and spending time pitching to them.

‍The acronym TAM, SAM and SOM represent the different subsets of the market.

What is TAM?

The term TAM stands for Total Addressable Market. This refers to the total market for the product or service you’re selling.

TAM is typically represented by a dollar figure of the maximum revenue your company can generate in a specific market. You can get this figure simply by multiplying your estimated average cost for your offering by the number of people or business in your total market.

You should also understand that not all companies can sell their offering to 100% of their TAM. That's because you'll need to assume that there will be zero competition in the market and your company will need to be a total monopoly in the specific market. That's highly unlikely if you're entering a lucrative market with high potential. By understanding your company's total potential for growth, it helps you create a value proposition for your business that can be used when pitching your startup to investors.

What is SAM?

The term SAM stands for Service Addressable Market. This refers to a drilled down segment of your total market that could be a geographical or industry subset.

SAM is also typically represented by a dollar figure of the potential revenue you can generate if everyone you sell to in your chosen niche buys your offering. For some, this can be identified as your 5-year plan where you have covered your local market and is ready to start entering new geographical locations or complementary industries.

A good example will be a specific city or state that you’re located in or a small country that is home to your startup.

What is SOM?

The term SOM stands for Service Obtainable Market. This refers to the realistic number of people and revenue you can capture.

You can identify this by looking at similar businesses in your market or other markets and seeing how their growth trajectory is like as a starting point. This can also be identified as your 1-year plan and the revenue you plan to generate within this first year of operations.

Why is This Important?

While the TAM SAM SOM as estimates, it’s a good way to establish the viability of the market you want to target. Having a good understanding of your target market, especially the SOM provides you with a good business case and demonstrates a deep understanding of your target audience in the market.

Where Do I Find the Numbers for This?

You can use secondary industry research parties to come up with the general numbers for your TAM and filter it down as you exclude companies along the way. This top-down approach is generally how founders define their potential market value. The only setback to this approach is the lack of up-to-date data and that limitation might require a little more guesswork to make the pieces fit.

There is also a bottom-up approach that starts with the number of potential customers you’ve identified in the market and multiplying that number with their average annual spending on your product. This may help you generate a much smaller number if you use a realistic figure to start with based on your capabilities and connections (if you’re a one-man army) but it can be more accurate. For this approach, you’ll think the same way to start with SOM as your 1-year target, SAM as your 5-year target and TAM as your total market.

Summing Up

Understanding a business' potential market size is a great way to determine whether an idea is worth pursuing and whether there's potential for growth. This data should set you up initially and consistently be updated to reflect the changes in your market.

By being data-driven, you can plan your business growth and determine where you should focus different marketing and sales efforts to produce maximum revenue.

When you decide to start a business, the first thing you should do is to calculate your TAM and SAM so that you can use it as a guide in the planning stages. This can be a useful tool you can use when pitching your startup to investors. Having a clarity shows your preparedness and gives confidence to investors. When investing in an unproven business, the quality of the founders stand above all else.

You can use this TAM SAM SOM template to help you get started with planning. There are also many other canvases and templates available on the Mad Creative Beanstalk's Free Resources page.

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